6/03/2009 @ 4:35PM

The Real Suckers Are In Cash

Let’s get a grip on reality. The bear market ended March 9, and the end of the worst recession since the 1930s–or is it the mid 1970s–is plainly in sight.

About $120 billion has been pulled out of global money market funds since mid-March; yet money market assets are still equal to 50% of the S&P 500 market cap. That is huge potential buying power. Since 1990, money market assets have averaged about 20% of the S&P 500 market cap.

There must be a horde of perplexed investors, like Croesus, who have been hoarding cash at no yield because risk aversion compelled them to adopt a conservative approach. Alas, they missed a rally in the S&P 500 that just polished off the best performance in more than 60 years, a 90-day steamroller worth 40% in recouped value. Up already 35% from its nadir in March, it looks like the Dow Jones industrial average will blow right through 9,000. Who knows, maybe 10,000 by summer’s end.

“We can’t say for sure that a new bull market has begun, but this looks to be a whole lot more than a bear market rally,” says BMO Capital Markets, a Canadian firm that produces succinct valuable insights. No more talk of a sucker’s rally. The suckers look to be on the sideline lending their money to banks at zilch.

Stocks broke higher on June 1 even though the yield on 30-year Treasuries climbed back above 4.5% last week. This is what the long bond yielded in August of 2008, just before the meltdown in credit markets during the fall of 2008. Today, the credit markets are healing, as spreads have fallen considerably, and corporations are able to raise tens of billions in the short-term debt market. The yield curve–the difference in yield between short-term and long-term securities–usually widens in advance of an economic recovery, and it has done so. Stocks also rose spectacularly despite the bankruptcy of
General Motors
and the continuing loss of jobs from the automobile industry. Bad news doesn’t seem to be rocking the market like it did a few months ago.

Earnings yields on equities still remain comfortably above the yield on 10-year Treasuries and should have the ability to absorb higher interest rates driven by economic recovery.

There are several other hopeful signs that the recession is near its terminus.

The U.S. manufacturing Institute for Supply Management index rose to 42.8 in May, which usually signals that gross domestic product is expanding rather than faltering. If this 42.8 level manages to rise, “there’s a good chance the recession will be over before the end of the summer,” says BMO Capital Markets. Amazingly, activity in private non-residential construction has also been rising, a sign that the recession may be losing its grip on the commercial property market.

Housing, the genesis of the crisis, is showing signs of stabilization and even amelioration. Pending sales were up 6.7% in April, even if prices are still in the tank.

Heck, even automobile sales improved in May to an annualized 10 million vehicle level, up from 9.3 million in April. This is the best month since last December, though still below the 12-month trend of nearly 11 million vehicles.

There has also been a mini-bull market going on in commodities that has been mightier than the one for stocks. This outperformance by commodities is another leading indicator of an economy about to turn the corner. Oil, which fell to $30 a barrel from $147 a barrel, is approaching $70 a barrel. This is driving the rebound in energy stocks, as well as the Russian market, which had been in the doldrums. Copper has moved higher by more than double.

Commodities can appreciate even more if inflationary expectations grow. Gold, which has rallied to nearly $1,000 an ounce, is being recommended for deflationary as well as inflationary times. It’s the way also to hedge against a declining dollar. Robert Smith, founder of Smith Capital, a fixed-income investment firm in New York, has been putting 5% to 10% of his pension clients’ money into gold through SPDR Gold Shares (nyse: GLD) and Canadian gold trusts.

Fear mongers raise the inflation warning as the next hurdle for equities. Maybe we’ll be surprised about it rearing its ugly head, but it seems two to three years away. Still we have to deal with rising unemployment, a sick Europe, falling real incomes, falling real personal outlays and weak industrial production.

Another factor that helps the Dow is the replacement of two stocks with no earnings–General Motors and
Citigroup
–with
Travelers
and
Cisco
. This triggers a reappraisal of the projected Dow earnings. The GM bankruptcy is no market-impacting disaster as its contribution to the nation’s economy is a fraction of 1% of economic growth, though unemployment will rise in the auto dealership and auto parts companies that service the industry.

Looks to Croesus that this market wants to rise, deflation or inflation both be damned!